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Compensation systems and earnings inequality


We develop a wage-structure determination model in which a firm with incomplete information offers an optimal sequence of contracts for its heterogeneous employees. The model integrating the principal-agent framework and monitoring mechanism is characterized by endogeneity of the selection of two compensation methods: performance-pay and non-performance-pay schemes. The model is used to examine the switching of pay schemes and its inequality effect. We point out that the growth of performance-pay jobs is accompanied by a downward adjustment of the rewards for performance, which brings forth a countervailing effect on wage inequality. The simulation analysis of a case of uniform-distributed ability reveals that the net effect of the growth of performance-pay jobs on wage inequality depends on the driving force behind the switch.

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Correspondence to Lily Jiang.

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Jiang, L., Yu, HC. Compensation systems and earnings inequality. J Econ Inequal 12, 99–116 (2014).

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  • Performance pay
  • Principal-agent theory
  • Earnings inequality

JEL Classification

  • D63
  • D82
  • J31
  • J33